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Commercial Real Estate Due Diligence: Leases

The Commercial Real Estate Due Diligence Process – Part 2 in a Series

Leases are Supremely Important
In the course of conducting due diligence, a buyer of a new commercial property must be sure that the lease(s) in place have key elements intended to protect his/her real estate investment.

Elements an Existing Lease Must Include
These are, first, escalations of rent, designed to serve as ballast against inflation and to increase revenue. Market value of property will be dependent on market rents, and a lease with locked-in rates from 10 years ago, without any provision for escalation for the next 15 to 20 years, is detrimental to a property’s marketable value. The second element, established guidelines for the use of the property, should fit your projected concept of use (both retail and office) and restriction of subleases. And the third: a comprehensive review of your tenant demographic.

Read Every Word of Every Lease (Followed by Another Set of Professional Eyes)!
Either a ‘stand-alone’ tenant lease, or the sum of the tenants’ leases, represents the future value of your investment. Take notes on things you don’t understand and then ask a seasoned mentor, or hire a real estate attorney, to carefully read over the leases. This part of the process is so important that I refuse to completely delegate it, but work on it with a team.

If you wish to draft a new commercial lease, I highly recommend turning over the task to your legal counsel, or use as a model the professional lease agreement readily available at web sites like kossresource.com

To be discussed in following blog posts: the importance of insurance and title policies in conducting due diligence.

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